Paul L. E. Grieco, Pennsylvania State University

Shengyu Li, Durham University

Hongsong Zhang, The University of Hong Kong

Importers and exporters may benefit from trade through a boost of productivity and/or lower input prices, although the trade literature mainly focus on the productivity effect. We examine the importance of both the productivity and input price effects of trade, by estimating a dynamic model of optimal production and trade participation allowing for unobserved heterogeneity in firm productivity and input prices. Our method recovers firm-level productivity and input prices controlling for firms' endogenous choices of input quality. Empirical results from Chinese Paint industry indicate that trade has impacts on firms through both the input price and productivity channels. Exporters benefit from increased productivity, and importers benefit from both strengthened productivity and lower input prices. Counterfactual experiments based on the dynamic model show that removing the gains from productivity and input prices channels separately lead to similar levels of loss of firm value in the long run, but are associated with different mechanisms. It is also shown that the import tariff cut after China joining WTO in 2001 increases average firm value by about 2.1 million US dollars through a direct effect on reducing input prices and an induced boost of productivity and trade participation.